VISTA LAUNCHES / What's next for Microsoft? Tech giant faces a future in which its OS may be supplanted by Internet technologies

Dan Fost, Chronicle Staff Writer

Published 4:00 am, Monday, January 29, 2007

With the release of Windows Vista, Microsoft Corp. hopes another wave of hype can once again cement its position at the top of the technology world. But many others in the business, long accustomed to having to swallow whatever Microsoft serves, are looking further ahead and wondering: Is this the swan song for the desktop operating system as we know it?

Microsoft has dominated the tech industry for years, and it seemed the Earth would shake with each new release of its cash cow Windows operating system. But the Redmond, Wash., behemoth is under siege. The personal computer is giving way to mobile devices, operating systems are going open-source, and companies like Google are offering a range of competing software that doesn't rely on Microsoft's platform.

Is Vista -- arriving years late and the target of critics and hackers -- the last gasp of a dying giant, compounded by founder Bill Gates' withdrawal from the day-to-day business? Or is it yet one more example of Microsoft's ability to spend billions, borrow the best ideas and emerge atop the technology world?

Time will surely tell. But the threat to Microsoft will probably take a long time to make significant inroads, if it is ever successful.

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"I think they are still the juggernaut they once were," said Brendan Barnicle, vice president and senior research analyst with Pacific Crest Securities. Barnicle does not own Microsoft stock, nor does his firm do banking business with the company. "Even with the success Apple has had, it has not changed the market data."

Indeed, Windows runs 845 million computers, according to a research report from Brent Thill, an analyst at Citigroup. Microsoft Office, the popular software that is also getting an upgrade, boasts more than 450 million users. Microsoft's old operating system, Windows XP, "is Vista's largest competitor," Thill wrote. Many users, especially corporations, are waiting for Microsoft to get the bugs out of Vista before jumping on the upgrade bandwagon, he wrote.

Barnicle said Vista's release won't have a big impact on Microsoft's financial picture. The company has done a great job of locking in the corporate market, which pays licensing fees, and that won't change, regardless of whether big companies stick with their old operating system or upgrade to Vista, he said. The consumer and small-business market "only impacts 20 to 30 percent of Windows revenue," he said.

Challenges ahead

And Microsoft has been nothing if not a revenue-generating machine. In the fiscal year that ended June 30, the company reported net income of $12.6 billion ($1.20 per share) on revenue of $44.28 billion.

Its second-quarter results, released last week, showed a 28 percent drop in earnings despite higher revenue.

Earnings were $2.63 billion (26 cents), down from $3.65 billion (34 cents) in the same quarter a year earlier. Revenue was up 6 percent to $12.5 billion.

Its stock, once a powerhouse, has been remarkably flat for the past several years, leading some to speculate that Microsoft's great growth days are behind it. The stock bottomed out last June at $21.46 per share but has rebounded significantly, closing Friday at $30.60.

The main challenge Microsoft faces is the way the Internet could ultimately do away with the personal computer. In the new era, analysts say, people are getting online with other devices, such as cell phones, personal digital assistants, MP3 players, game consoles and television sets. Microsoft's virtual monopoly on desktop operating systems, which once brought it a raft of trouble in the form of antitrust lawsuits, may no longer matter in this new world.

As the Web becomes a platform of its own, people can turn to free software to do the things they once had to pay Microsoft big bucks to do. Google Inc., the Mountain View search-engine company, seems most interested in moving into this territory. It has released or acquired a variety of products that compete with the elements of Microsoft Office -- Microsoft Word, Excel, Outlook and PowerPoint. Instead of charging users, Google supports its products with advertising.

Last year, Google acquired Writely, a free word-processing program, renaming it Google Docs and pairing it with its free spreadsheet offering. Its Gmail e-mail service could take on Microsoft's Outlook. Google's applications will run on any operating system.

For evidence that Wall Street is far more bullish on Google's future than it is on Microsoft's, consider that Google, in the 12 months that ended Sept. 30, had net income of $2.4 billion on revenue of $9.3 billion -- a fraction of Microsoft's -- but its stock had soared, closing Friday at $495.84 per share. Google will report results for 2006 on Wednesday.

"The operating system is less important than it used to be," said Michael Silver, vice president of research at Gartner Inc. "But the old stuff doesn't disappear all that quickly."

If you're running a big company, he said, you rely on Office, and you aren't ready to trust a free program to take its place.

Windows Live, Office Live

Silver said the operating system of the future may indeed be more modular. Instead of paying a big chunk of cash to get a big chunk of software, consumers might get the software through a subscription that would be periodically updated over the Internet. Google's software operates this way.

Microsoft has taken the first baby steps in this direction, releasing Windows Live and Office Live. These are mostly free and ad-supported, but contrary to their names, they are not versions of the company's Windows and Office cash cows, but different businesses entirely. Office Live is a small-business service, and Windows Live is a set of online services such as search, e-mail and news updates -- the sorts of things people now get on, say, a personalized home page from Yahoo.

But analysts said that while that model is working for other types of software, the operating system is bigger and more complex. And while Microsoft may be losing ground to Google today, people who have watched Microsoft over the years don't usually like to bet against it.

"Does it take Microsoft a few iterations to get something like this right?" asked Silver. "Yeah."